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Top 5 Strategies to Diversify Your Investment Portfolio

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In the world of investing, it is important to diversify your investment portfolio. Investors are always after making a lot of money with minimal risk. And the most effective strategy to achieve this is through diversification. Irrespective of your investment knowledge, a well-diversified investment portfolio is important. But what does diversification mean, and why is it so crucial?

This article will help you understand how to build a diversified investment portfolio.

What is portfolio diversification? 

A popular saying is, “Do not put all your eggs in one basket.” It means don’t put all your resources in a single source. Because no one knows the future, it is better to spread out your resources. This is what diversification of investment is. 

Diversification is an investment strategy that spreads your investments across various asset classes. The spread can also be across sectors and geographic regions, but its primary goal is to reduce risk. Instead of putting all your money into one stock or asset, diversification is mixing them. A portfolio is the collection of a kind of asset class.

Due to uncertainty, most investors prefer to diversify their investment portfolio. The performance of different investments tends to vary under different economic conditions. If we all know the future, we would not need to diversify our investments.

During COVID-19, investors who own shares in the transport sector incurred losses. But those who had shares in pharmaceutical companies made a profit. Imagine an investor owned shares in both sectors, he can compensate for the loss in one with another. 

Common strategies to diversify your investment portfolio

1. Spread investment across asset classes

This strategy involves diversifying your investment portfolio across various asset classes. It helps to reduce risk by balancing different types of investments.

Your investment portfolio can contain popular investments like stocks and bonds. It can also include alternative investments traded in the private market.

For instance, you can invest in stocks of companies like Apple and Microsoft for growth. If your goal is stability, U.S. treasury bills are a good option. The Real Estate Investment Trusts (REITs) such as Vanguard Real Estate ETF (VNQ) are also open. 

Fund managers use this strategy to help their investors make money and reduce risks. The Yale Endowment Fund is an example. It employs a strategy that allocates 60% of holdings to stocks and 40% to bonds.

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2. Diversify within asset classes

This second strategy is like the first one. It is like a topic and subtopic. Diversify your portfolio within an asset class after diversifying it across different classes. If you have a stock portfolio, it should contain a mix of stocks of different companies and sectors. Instead of investing in one stock, have a mix of different companies and sectors’ stocks.

Instead of focusing on stocks of technology giants like Apple or Microsoft, make it a mix. You can invest in healthcare companies such as Johnson & Johnson. Financial firms like JPMorgan Chase are a good option too. Consumer goods companies like Procter & Gamble are worth the risk as well. For bonds, look at government, corporate, and municipal bonds. In real estate, consider residential, commercial, and REITs (Real Estate Investment Trusts).

During the 2008 financial crisis, investment in financial services suffered losses. Investors with diversified portfolios that included stocks in healthcare and consumer goods won. Diversifying within asset classes helps balance risks. It also captures growth opportunities across the market.

3. Consider diversifying abroad

Most investors only prefer the investment options in the U.S. that they forget the rest of the world. You can diversify your investment portfolio by investing in assets abroad. The emerging markets or Europe are good places to start from. For instance, China is growing at a faster long-term rate than the U.S., so companies based there may benefit.

Exploring international markets will expose you to different economic conditions and growth opportunities. It will also shield you from any negative event that might impact the U.S. in particular.  

Mutual funds and ETFs (Exchange-Traded Funds) are good starting points for this strategy. 

4. Use Mutual Funds and ETFs

This portfolio diversification strategy has proven to be effective among investors. It involves crowdfunding to buy diversified baskets of securities at low cost. A mutual fund or ETF is an index fund that tracks specific market indexes. One of its major advantages is that it offers broad market exposure at a low cost.

For example, the Vanguard Total Stock Market ETF (VTI) offers exposure to the entire U.S. stock market. Also, the Fidelity Total Bond Fund (FTBFX), diversifies across various bond types.

A notable case study is the SPDR S&P 500 ETF (SPY) which is synonymous with the S&P 500 index. Both indexes give access to invest in 500 leading U.S. companies. During the 2008 financial crisis, SPY helped investors mitigate losses by investment diversification. They would not be able to achieve that if they had concentrated on specific sectors or stocks.

5. Practice checks and balancing

After allocating funds to your assets, it doesn’t always remain the same for a long while. So, you have to keep making sure it stays at your desired allocation. Let’s assume you desire to divide 40% of your fund into stocks, you have to keep adjusting it.

Imagine you have stocks in Apple (AAPL) and Amazon (AMZN), and Treasury bonds. If tech stocks surge, your investment portfolio might become too concentrated in equities. For long-term financial stability, rebalance by selling some stocks and buying more bonds. It helps to maintain the intended risk level.

Regular rebalancing is a proven strategy to maintain a diversified investment portfolio. Besides, it helps you to make sure you maintain your risk profile. Vanguard’s Target Retirement Funds works based on this strategy. Invested funds immediately rebalance, adjusting the asset mix as the target date approaches.

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Conclusion

Diversifying your investment portfolio is an effective strategy for managing risk. Much more than that, it can help you get more stable returns. Mixing your assets across various classes, sectors, and locations helps protect your portfolio. Diversification doesn’t guarantee profits, but it’s a tool for a balanced investment strategy. Irrespective of your investment knowledge, diversification can help you reach your financial goals.

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Olamide Francis is an SEO content writer and contributor at EntrepreneurBusinessBlog.com. You can connect with him via [email protected].

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